Where’s My Canceled Check?: A Review of the Basics

The
Check Clearing for the 21st Century Act (Check 21 Act),
P.L. 108-100, was signed into law on Oct. 28, 2003, and
went into effect on Oct. 28, 2004. For most consumers,
this means that they now receive scanned images of their
canceled checks in bank statements rather than the
actual canceled checks; in some cases, they are not
receiving even those. However, during an IRS audit, some
IRS requests for information insist on substantiating
expenditures with front-and-back copies of canceled
checks.

The Check 21 Act enables banks to handle more
checks electronically so they can process them more
quickly and efficiently (Check 21 Act, §2). Moving
paper checks is costly and slow. When a paper check is
first deposited or cashed at a bank, a picture of the
front and back of the check is captured and, from that
point on, the image is transmitted electronically.
With agreements between banks and their customers,
except where the banks have agreed to provide canceled
checks in their statements, the Check 21 Act permits
the banks to provide either the original check or a
“substitute check” (defined below) “or, by agreement,
information relating to the original check (including
data taken from the MICR [magnetic ink character
recognition] line of the original check or an
electronic image of the original check), whether with
or without subsequent delivery of the original paper
check” (Check 21 Act, §3(18)). After doing this, the
bank generally is allowed to destroy the original
check as provided in its customer
agreement.

What happens when the IRS conducts an examination
and asks for a canceled check to substantiate payment
of an expense? Usually, as it has been doing for many
years, the IRS accepts a copy of the canceled check.
So taxpayers must take extra care to protect the
copies of checks that may accompany their bank
statements. Of course, the bank normally has quick
access to copies of these checks. In rare instances
where the IRS demands more than the copy of the
canceled check included in the bank statement,
taxpayers can request a substitute check from the
bank. A substitute check is legally the same as the
original check if it accurately represents the
information on the original check and includes the
following statement: “This is a legal copy of your
check. You can use it the same way you would use the
original check” (Check 21 Act, §§4(b)(2),
4(e)).

If a taxpayer receives a substitute check that is
not legally the same as the original check and suffers
a loss related to the substitute check, the Check 21
Act provides the taxpayer with a special procedure
that can be used for restitution (Check 21 Act,
§6(a)).

The
IRS has indicated that it generally will accept
photocopies of substitute checks as proof of payment.
However, as has been IRS policy for copies of canceled
original checks, if an IRS auditor suspects that the
copy is not genuine, he or she may ask the taxpayer to
order the actual substitute check from the bank. The
taxpayer’s general recordkeeping obligations under the
tax law are satisfied by keeping the bank
statements.

Note
that the Check 21 Act procedure is far different from
the electronic check conversion process that has been in
use for many years, in which a bank customer’s check is
converted to an Automated Clearing House (ACH) debit.
The money is taken out of an account, or the taxpayer
may authorize an electronic check and pay a bill by
telephone or online. Customers’ rights using ACH debits
and electronic checks are far different from their
rights under the Check 21 Act, since the only record of
an electronic check may be the notations on the bank
statement.

The
key points to remember with the Check 21 Act are:

If a taxpayer is receiving canceled checks now,
that will continue until the bank sends notification
to the contrary.

If taxpayers have online
access to bank statements, they should download and
save the electronic copy of the statements and
checks as a backup.

Banks are not required
to keep original checks for any specific length of
time, and the Check 21 Act does not add any
retention requirement.

Banks are required
to notify customers if they change the way they have
been providing canceled checks or copies.

Banks may provide a substitute check but are not
required to do so. Customers need to understand what
their bank will provide.

Even if the bank
does provide a substitute check with the proper
language, it may charge for this service.

EditorNotes

Valrie Chambers
is a professor of accounting at Texas A&M
University–Corpus Christi in Corpus Christi,
Texas. Robert Moïse is a partner with
WebsterRogers LLP in Charleston, S.C. Prof.
Chambers and Mr. Moïse are members of the AICPA
Tax Division’s IRS Practice and Procedures
Committee. For more information about this
column, contact Prof. Chambers at valrie.chambers@tamucc.edu.

The winners of The Tax Adviser’s 2016 Best Article Award are Edward Schnee, CPA, Ph.D., and W. Eugene Seago, J.D., Ph.D., for their article, “Taxation of Worthless and Abandoned Partnership Interests.”

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